Shares of military shipbuilder Huntington Ingalls (NYSE:HII) popped 5% after reporting Q2 2018 earnings on Thursday, then gave have those gains back on Friday. For the most part, the stock's 5% gain can probably be attributed to the fact that it beat earnings, reporting $5.40 per share in profit when Wall Street had expected it to earn only $4.09. Sales also met expectations, coming in precisely at the consensus-estimated $2.02 billion.
But aside from the fact that it beat expectations, what else do we know about Huntington's performance last quarter?
The tax man giveth
We know that sales grew about 9% year over year, but profits per diluted share soared 68% -- which is kind of incredible. Huntington Ingalls explained, however, that much of its increase in earnings came courtesy of the IRS, which allowed Huntington to take "higher research and development tax credits for the post-spin-off 2011 through 2015 tax years," and charged it a "lower statutory federal income tax rate". So you can thank tax reform for the beat.
Operating profits did climb as well, of course, although they were up only 7% year over year as Huntington generated a lower operating profit margin this quarter than one year ago, down 30 basis points to 12.7%. Huntington also benefited from a smaller share count, which concentrated net profits among fewer shares outstanding.
But changes in the tax rate were primarily responsible for the company's big earnings beat.
Breaking it down
Huntington Ingalls operates three main divisions of vastly different sizes. Luckily for Huntington, its biggest business -- Newport News Shipbuilding, which builds nuclear-powered submarines and aircraft carriers -- had the best news in Q2. Sales there surged 18% year over year. Profit margins slipped 30 basis points, but even so the big boost in sales sent operating profit up 14%.
That's good news because Ingalls Shipbuilding, the division that builds conventionally powered warships such as destroyers and amphibious assault vessels, suffered a much bigger margin decline. Ingalls is only half the size of NNS, but usually earns much bigger margins (13.2% versus NNS's 7.7%). That gap narrowed in Q2, however, with Ingalls' margin suffering a big 214 basis points-decline. Sales also slipped 2%.
The company's much smaller and much less profitable Technical Solutions division, which focuses on nuclear energy, saw sales slide less than 1%. Margins declined only 81 basis points -- but TS only had a 3.7% margin to begin with. Now it's earning just $0.029 on each revenue dollar.
Forecasting the future
Huntington Ingalls management didn't provide guidance for the rest of the year (or beyond it) in its earnings release, but one note buried in the middle of the release suggests the company could be sailing into troubled waters. In Q2, Huntington says it "booked" only $1.1 billion in new contracts. That's nowhere near enough new revenue to replace the $2 billion in revenues "billed" in the quarter, giving Huntington an unimpressive 0.55 "book-to-bill" ratio.
Now, the news isn't quite as bad as this makes it sound. Book to bill ratios can be lumpy, especially in the defense business, and especially in a business where one quarter can see a company win a contract to build a $14 billion aircraft carrier, and another quarter not. To smooth out that lumpiness a bit, consider that in Q1 Huntington Ingalls booked $2.6 billion in new orders, and billed $1.9 billion. Over the past six months, therefore, Huntington's book ($3.7 billion) to bill ($3.9 billion) ratio is a more palatable 0.95.
So long story short? It's not exactly "all stop" for Huntington Ingalls just yet, but the past six months' results still imply a slowdown in revenue growth going forward. This makes it all the more important that when Q3 results roll around three months from now, we see Huntington not just meet or beat Wall Street's consensus, but grow its order book faster than its sales as well. That will be the surest compass by which to chart this stock's future.